Dollar soars as Bank of Japan follows ECB lead and shocks markets with new monetary stimulus

The Bank of Japan stole the spotlight last week, taking markets completely by surprise with new easing measures. The contrast with the FOMC’s moderately hawkish statement earlier in the week could not be starker. The divergence between US monetary policy and that of just about any other major G10 central bank, the Bank of England possibly excepted, is now impossible to ignore and thus the Dollar continues to rally in spite of the high level of consensus both among strategists and traders. Last week’s gain for the greenback ranged from a moderate 0.7% against Sterling to a massive 4% move against the Japanese currency. We think that the ECB will be next in line in announcing further monetary easing as early as Thursday, when the Governing Council meets.

GBP

Last week was relatively quiet in the UK, as events elsewhere overshadowed mostly second tier economic data. Nevertheless, two MPC members made public comments supporting our view that the Bank of England is turning more dovish. The prospects for Bank of England hikes are being pushed further into the future. Mortgage approvals continue to fall, providing comfort to the BoE that the housing market is not bubbling up, and removing the main concern about keeping rates at near zero levels. UK news continue to come in on the soft side, but still much stronger than across the Channel, and therefore Sterling continues to perform half way between the greenback and the Euro, falling 0.7% last week against the former while rising an almost equal amount against the latter.

EUR

Mixed news again out of the Eurozone. Inflation edged higher, to a still dangerously low 0.4% YoY, but core inflation was essentially unchanged – dropping 0.1% to 0.7% mostly due to rounding effects. Unemployment held steady at a dismally high 11.5%, and leading indicators appear to have stabilised at a low level. We expect the ECB to look past these short-term data points and focus squarely on its failure to push inflation towards its target, announcing new easing measures at its monthly meeting on Thursday. Meanwhile, the irruption of the left-wing coalition Podemos, less than a year old and already topping the polls in Spain, together with the clear lead of its Greek counterpart Sryza in Greek polls, suggest that the European electorate’s patience with the Eurozone’s disastrous economic performance may be coming to an end.

USD

Last week’s crop of economic news highlighted the large divide in economic performance between the US and other major advanced economies. GDP grew by 3.5% in the third quarter, above consensus expectations. Perhaps more importantly, the Employment Cost Index rose much more than expected. Hourly wages and salaries have now increased at a 3% annualised rate for the past six months – the first sustained real increase in wages for US workers in many years, and a sign that the labour market may be healing faster than the Federal Reserve expected. The FOMC itself validated this view in a statement released last week. It sounded more optimistic about both the labour market and the prospect for restoring inflation to the 2% level. Interest rate markets expect the first hike in June; we think this time frame is quite reasonable.